The Hindu Business Line : Psychology of cash discount

Consider this. You walk into a local store and buy groceries. When you dish out your credit card, the counter clerk tells you that will receive a 2 per cent discount if you pay cash. Would you? If you are a typical consumer, you will still use your credit card. Why?

The store understands consumer psychology. That is why it offered you a cash discount. You figure that 2 per cent is a small price to pay for the convenience of using the credit card. So, you use the “plastic”.

But instead of offering a cash discount, what if the counter clerk told you that you will have to pay 2 per cent of the cash bill as additional charge for using the credit card? You may then choose to pay cash. Why?

Framing bias

The reason is because of what behavioural psychologists call as the framing bias. Long back, Kahneman and Tversky, two psychologists, had posed a question to their subjects. The question was about two programs to fight a certain disease.

The subjects chose Program A when the question was framed in terms of saving lives. But the same subjects chose Program B when the question was framed in terms of number of deaths.

The cash discount and credit charge is a similar case of framing bias. Remember, in both cases, the cost of using credit card is 2 per cent. You gain 2 per cent when the store offers cash discounts. You, however, lose 2 per cent when the store charges you for the credit transaction.

Taking pains to avoid losses

Now, you may remember loss aversion effect in behavioural economics. It states that we take great pains to avoid losses. That is, we are more likely to give up gains than accept losses.

It naturally follows that we give up the 2 per cent cash discount to use the credit card. But when faced with a 2 per cent credit charge, we are more likely to pay cash to avoid losses (cost). And that seems to be the psychology behind the cash discount.

(The author is an investment strategist. blfeedback@thehindu.co.in)

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